Skills That Separate You as an Investment Manager: Context Creation

For nearly a year now I have been discussing skills that separate you as an investment manager. Wide territory is covered in other articles in the series, ranging from introspection to scaling. Context creation, this month’s subject, takes advantage of intuition, creativity, and a person’s knowledge. Like other topics discussed so far, I address context creation at length in my book The Intuitive Investor.

Defining Context

Context is defined roughly as the circumstance in which an event occurs; a setting. Let’s break this down, starting with the word circumstance. “Circum” comes from the Latin word for circle and it suggests encircling, surrounding, and demarcating — in other words, to separate something from a larger whole.

“Stance,” meanwhile, refers to the location of a thing, a person, an idea, an opinion, and so forth. Investing examples include nations, economic output, industries, businesses, products, competition, business executives, business models, strategies, and many others.

Last in the definition of context is “setting,” meaning the environment or arena in which something takes place. Again, settings may include the economy, the financial markets, economic policies, a nation’s legislature, etc.

Taken together all of these micro definitions mean that context is about identifying the important investable information (signal) from all other information (noise). Proper context is entirely up to the investor to establish for herself and is a critical choice when it comes to investing. Ideally analysts and portfolio managers constantly change and scale their contexts until they understand the information before them.

Choosing context immediately places investors into an intimate relationship with the information under consideration because it relates your mind and your choices with the real world. If you do this wrong then you have a distorted view of reality. But if you choose wisely, clarity ensues.

Context Helps You to Ask the Right Questions

A further refinement of context choosing is context creation. It is easy for investors to let convention determine contexts when seeking understanding. For example, it may be convention in an industry to look at specific factors, such as same-store sales per square foot in retail, or revenue per passenger mile (RPM) in the airline industry, or net income per barrel of oil equivalent (BOE) in the oil industry. How you project financial statements into the future is a preselected context for trying to understand businesses, as are financial statement analysis and financial ratio calculation.

Yet, truly skilled investors create their own contexts to try and understand the world around them. So when Russia annexed Crimea in early 2014 and then decided to involve itself in the politics of its immediate neighbor, Ukraine, many pundits borrowed an old and familiar context to try and understand the events — namely, the Cold War politics of a previous generation.

Once the Cold War context was chosen, then most of the “work” of trying to understand Russia’s actions was already taken care of. The conventional wisdom of journalists and politicos was a resuscitation of Russia as the Soviet Union by Vladimir Putin. Yet, choosing the answers of the “Cold War” context obscured the right questions to ask. What about creating your own context to understand? What about asking the following context shaping question:

Does Russia have the military might to crush Ukraine if it wanted to do so?

The answer to this question is/was, “yes.” A natural follow-up question was then suggested to those who can create their own contexts:

Given that Russia can crush Ukraine militarily, then why haven’t they done so? Their actions must be about something else.

Here creation of your own context leads to an entirely different set of questions and therefore an entirely different way of understanding those fast-evolving, hard-to-discount problems.

Context Gives Facts Meaning

Context is always important because facts alone have no meaning. Facts, in and of themselves, exist without context, yet it is context that gives them meaning and turns them into actual, actionable information. Facts without context lie undifferentiated on the investment landscape.

For example, consider the following statistic:

Real gross domestic product (GDP) increased 4.9%.

What does this fact mean? You may think you know, but many assumptions must be made to believe this fact has relevance. Maybe the assumption is that the statistic pertains to your home country. But without the country in question being named, there is no context and no understanding and no real information conveyed.

How does the analysis shift if, in fact, the country in question is Mozambique? Next, what time frame is being considered above? Knowing that it is the third quarter of 2007 for the United States provides more context, but not much.

Even with this information, the context of a question — itself the result of creativity and intuition — is needed to understand the statistic’s importance. What if the question is, “How did third quarter 2007 United States GDP compare to the same quarter in 2006?” (By the way, this question I would characterize as conventional context that likely leads to conventional understanding and hence conventional results.)

But what if the question is, “What gives you confidence that US consumers felt good about the economy in the third quarter of 2007?” Here the question — i.e., the context created — changes the understanding and relevance of the facts at hand.

Many investors treat facts as answers to questions, yet they never consider what question the facts are supposedly answering. Investors also rarely check to see if there is congruency between the answer and the question.

Answers can exist by themselves but it is the question that gives them meaning. The opposite is also true: questions really only have meaning depending on the answer.

When an analyst is diligent about creating context then it is more likely that questions and answers are in accord with one another. And when this is true then confusion is minimized, and the likelihood is much higher that an investment manager has a true understanding of the world.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Jason Voss, CFA, tirelessly focuses on improving the ability of investors to better serve end clients. He is the author of the Foreword Reviews Business Book of the Year Finalist, The Intuitive Investor. Previously, Jason was a portfolio manager at Davis Selected Advisers, L.P., where he co-managed the Davis Appreciation and Income Fund to noteworthy returns. He holds a BA in economics and an MBA in finance and accounting from the University of Colorado.

Ethics Statement

My statement of ethics is very simple, really: I treat others as I would like to be treated. In my opinion, all systems of ethics distill to this simple statement. If you believe I have deviated from this standard, I would love to hear from you: jason@jasonapollovoss.com

2 thoughts on “Skills That Separate You as an Investment Manager: Context Creation”

More than 130 business leaders have responded to a deadlock in the UK Parliament by signing a letter calling for a second Brexit referendum to prevent a chaotic withdrawal from the EU. "The only feasible way to do this is by asking the people whether they still want to leave the EU," the letter says. CNBC (17 Jan.)

The Chinese government is likely to establish a growth target for this year that falls short of the 6.5% target set for 2018, sources said. This year's target is expected to be 6% to 6.5%. China Daily (Beijing) (18 Jan.)

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